Make Sure Your Portfolio Can Survive Anything

Make sure your portfolio can survive anything... Don't let this idea scare you... The easiest way to drastically improve your investment returns...

If you're worried about the stock market today, you need to read today's Digest...

There's a group of investors out there that is weathering this storm... They aren't experiencing the large losses and volatility most folks are battling on a daily basis... And they're able to sleep well at night knowing their portfolio is prepared for anything that may come.

The topics I (Porter) will discuss today should make (and save) you more money than any other advice I can give you. But you have to read today's essay carefully. You have to think about these concepts. And you have to promise yourself that you'll take the time to implement them.

I know hardly any of you will take these concepts to heart... Fewer will actually take action – even though it's one of the simplest and easiest things you can do – and it will make you a fortune over your lifetime.

So why do I bother writing to you about things I know you won't do? Because, as I often state, my goal is to give you the information I'd want if our roles were reversed.

If you take nothing else away as a Stansberry Research reader, let it be this...

The greatest investors in the world already know this secret. It's so simple, but it can make you a better investor overnight. It will transform a losing portfolio into a winner. And it has nothing to do with the stocks you buy or trailing stops.

I'm talking about using risk-adjusted position sizing.

Have you ever looked at your portfolio and noticed most of your best-performing investments are in the lowest-risk names? Companies like Berkshire Hathaway (BRK-B), Microsoft (MSFT), and Apple (AAPL), for example.

Look at the best-performing open positions across all of our editors' portfolios at the bottom of each Digest...

Constellation Brands (STZ) – the owner of alcohol brands like Robert Mondavi and Corona – has returned nearly 600%. Tobacco giant Altria (MO) is in second place, followed by fast-food icon McDonald's (MCD).

Buying big, safe, slow-growing businesses has proven time and time again to provide the highest investment returns.

Yes, we all know "Warren Buffett-style investing" can make you rich. But what's the actual reason this investment style works?

As I wrote in the October 16 Digest...

These stocks have a few standout quantitative traits aside from these qualitative basics that can help you identify them in advance. First, they pay good dividends and have a long history of growing those payouts over time. And second (and this is far less understood by most investors), their share prices aren't volatile. Their stock prices tend to move around a lot less than the market as a whole. That's because they have a stable cohort of investors who own the company – investors who are unlikely to sell.

I explained that academics measure this advantage by comparing the daily volatility of a company's share price with the volatility of the benchmark S&P 500 Index – which is composed of the 500 biggest publicly traded companies in the U.S. This is called "beta." As I noted...

Stocks with a volatility equal to the S&P 500's average are awarded a volatility score of "1." That is, the volatility of these stocks is perfectly correlated with the market as a whole. Stocks that move around more have higher betas. So a company that is 50% more volatile than the S&P 500 would have a beta of 1.5. A company that is two times more volatile than the S&P 500 would have a beta of 2, and so on.

In other words, these high-quality companies are more likely to have dedicated, long-term investors. They're not trading in and out of stocks. As a result, the share prices of these businesses move around less than the average publicly traded company.

I've long suspected buying these types of businesses would lead to outperformance in our readers' investment returns. But I wasn't able to prove it until I saw a presentation from Dr. Richard Smith at our annual conference last year in Las Vegas. From the stage, Richard explained...

We put together a group of 40 real-life portfolios – real buy and sell data from real investors. I asked my team to back-test all of our different stop-loss and position-sizing strategies against these real portfolios to see which of our tools made the biggest difference in performance... And I was amazed to see that there was one tool that improved investment performance more than anything else: volatility-based position sizing. If you only ever pay attention to one thing that I have to say, this is it – use volatility-based position sizing.

Don't let the term "volatility-based position sizing" scare you away... It's simply using the volatility of a stock to determine how much of it you should own relative to the size of your portfolio. Ideally, you'd have the same amount of risk in every stock you own.

The concept is simple, but implementing it is a bit tougher. That's why this type of strategy has long been largely exclusive to the world's best banks and hedge funds. Luckily, Richard – who studied math at Cal Berkeley and went on to get his PhD – solved that problem for the individual investor. He built an algorithm that determines the volatility of your portfolio, and tells you how many shares to buy of a given stock (any stock) so your portfolio is "risk-weighted," meaning each position carries the same amount of risk.

More simply... The program keeps you from loading up on risky stocks and helps you buy more high-quality, safe stocks like the ones we recommend. You can still swing for the fences with the "sexy stock du jour"... you just do so with much less risk.

Let me share the details of the study Richard conducted. From that Digest...

To back-test the strategy, Richard took the 40 investor portfolios and figured out how much of each stock these investors would have bought if they had built risk-weighted portfolios instead of using their actual allocations. Just making this one change – just changing the amounts of shares they bought – almost doubled the average returns of the portfolios he studied.

As I explained, Richard didn't change the stocks, purchase dates, or sale dates these investors bought. He only changed the relative amounts of each investment...

Just making that one change saw the average return go from 6.7% to 12%. No other form of portfolio management – not even smart trailing stops – made as big of an impact.

Why did causing investors to focus on volatility work so well? Because volatility (as measured by beta) is a great indicator of risk. Colleges still teach that in the financial markets, risk equals reward. That might even be true in a lab setting. But it's not true at all with real live human beings. Most investors who set out to practice "buy-and-hold" investing end up doing "buy-and-fold." That is, they end up selling at precisely the wrong time... when fear in the market is peaking.

The result of Richard's study is a new tool he created for his best clients at TradeStops. You link your existing portfolio with this software, press one button, and it shows you how risky your portfolio really is. Press another button and the software shows you how to balance risk across all of your existing positions – and exactly how many shares you should own of each stock.

Linking your portfolio to this software and pressing two buttons will be the easiest and most profitable thing you do in your investing career. There isn't a single other thing you could do – certainly nothing as easy – that will drastically improve your investment performance.

Nobody is perfect. We all swing for the fences from time to time. And sometimes it works – just look at Steve Sjuggerud's Seabridge Gold recommendation atop our Hall of Fame. But Richard's software will allow you to do so with much less risk. And it will vastly improve your long-term returns.

Here's an example of one portfolio Richard examined during his back-testing study...

No. 438. (The investor account names were hidden and each account was assigned a reference number.) This investor had $434,000 in his account. Over the period of the study, he lost 23.1% of his savings – just more than $100,000. That's a massive, horrific loss.

But using Richard's volatility tool to change the position sizes of his actual investments, his portfolio would have produced a total return of $59,494 (a gain of 13.7%). Note: This simulation did not change the stocks purchased or the timing of the buys and sells. It merely changed the position sizes by equalizing the amount of risk in each position.

Let's look at a real-time example, applying Richard's software to today's market...

Anyone who invested in gold stocks over the past several years has taken huge losses. The selloff across natural resources has been long and brutal. Using Richard's software, you would have greatly limited your exposure to this sector.

But what about today? Gold is coming off a great week, trading at more than $1,160 an ounce. Gold stocks – as measured by the Market Vectors Gold Miners Fund (GDX) – are up more than 30% off their recent lows.

What if you want to dip your toe back into gold stocks? How do you do that in an intelligent way?

After all, fortunes have been lost by investors trying to call the bottom on volatile sectors like gold.

That 30% rally may make you believe gold is off to the races... and that if you don't get in now, you'll get left behind.

That's how disasters happen. That's how Investor 438 (discussed above) lost nearly 25% of his portfolio on just a handful of trades.

So before going "all in" on gold stocks, you need to figure out how much money you're willing to lose in case you're wrong.

According to Richard's software, the volatility factor on GDX is currently 36.5%. That's how much GDX tends to swing up or down over the course of a year or more. To put that in perspective, the S&P 500's current volatility factor is just 10.8% using Richard's system.

This volatility risk of GDX is the basis for deciding how much to invest in GDX. Here's how it works...

Let's say that you decide that you're willing to LOSE up to $1,000 on a GDX speculation today. Take your $1,000 and divide it by the volatility factor for GDX. That's $1,000 divided by 36.5%.

That gives you $2,740, which is the amount you can invest – if you're willing to get out if GDX falls 36.5%. If GDX does fall 36.5%, then your $2,740 investment in GDX will be down $1,000.

Of course, how much you're willing to lose is up to you. But a good rule of thumb is to only risk 1% of your portfolio on any given trade.

What would you pay for lifetime access to a system that basically guarantees to vastly improve your investment results? Whatever the cost, you would make it up with your investment gains. People are already seeing great results from Richard's program...

"I love you guys, I feel a lot calmer about my stocks, I feel like you are an insurance company that helps me not lose my hard earned money. I feel much safer with you on my team, keep up the great work. You guys are mathematical geniuses." – Theresa H.

"I have been a subscriber to your service for several years and I am delighted with it. You keep on improving the software and as they say in the service 'you go above and beyond the call of duty.' Thanks!" – Tom C.

But this tool is only available to Richard's lifetime subscribers. It's part of a group of services Richard has designed to give individual investors access to the same systems professional investors use – systems that drastically reduce your risk and improve investment performance.

If you invest in stocks, you should absolutely sign up for Richard's service. It's simple to implement. It will improve your investment results. And it could be the single most profitable decision you make.

If you're ready to start using volatility-based position sizing – in addition to other services that will make your portfolio safer – you need to sign up for TradeStops. With Richard's services, you just hit one button to know how many shares you should buy of any stock to equalize the risk in your portfolio. You can also use his service across your existing portfolio to rebalance it with the proper risk.

And right now, you can get lifetime access to TradeStops for more than HALF off the normal price... And Richard has agreed to throw in several other "goodies." Click here to take advantage of this special offer.

New 52-week highs (as of 2/4/16): Nuveen AMT-Free Municipal Income Fund (NEA), Nuveen Premium Income Municipal Fund 2 (NPM), Nuveen Municipal Value Fund (NUV), OceanaGold (OGC.TO), and Sysco (SYY).

Have you used Richard's TradeStops software? We'd love to hear from you. Send your e-mails to feedback@stansberryresearch.com.

Regards,

Porter Stansberry
On Two Suns somewhere in the Atlantic Ocean
February 5, 2016